Nicholas Grove: When confronted with the prospect of investing in the listed infrastructure space many people maybe scratching their heads after being struck by the sectors apparent complexity, but here to help investors navigate these waters, I'm joined by Morningstar's Senior Equities Analyst, Adrian Atkins.
Adrian, thanks very much for joining us.
Adrian Atkins: No problem, Nick.
Grove: First of all Adrian, can you give us a brief idea about and a few examples of the kinds of companies that make up this sector and what it is they do?
Atkins: Sure. There is four broad categories of infrastructure stocks listed in Australia. We've got: regulated utilities, unregulated utilities, toll roads and airports. So the regulated utilities own the poles and wires, and the gas pipelines that connect to our houses located in cities. The unregulated utilities own long-distance gas pipelines running from gas fields to cities. Then toll roads - pretty straightforward; and airports as well.
In the regulated utilities sector we've got SP AusNet and Envestra and other companies. In unregulated space we've got APA Group and Hastings Diversified Utilities Fund. In the toll roads there is Transurban and for airports there is Sydney Airport.
Grove: Adrian, all the stocks in this sector what you would describe as defensive income stocks?
Atkins: Yes, they're all defensive, some more so, I think, probably airports are the least defensive. But the other thing you need to consider is the level of gearing they have, and because they have such stable revenues they all use quite a lot of debt, which is fine at most points in time, but whenever you get a credit crisis it can put them under little bit of pressure. They've all cleaned up their balance sheets a lot since the GFC, so we're not expecting anything disastrous. But nonetheless it is something that you have to be aware of.
Grove: Adrian, in the recent report you discussed the relationship between these stocks and falling interest rates. Would you mind just elaborating briefly on this relationship?
Atkins: Sure. We were looking specifically at the regulated utilities, because for the regulated utilities the regulator decides what a fair amount of profit is and he works that out, part of it is interest rates. So, as interest rates fall, he recalculates the amount of profit and he should all else equal come up with the small profit number.
So, we are a little bit concerned for the regulated utilities. We think that the next regulatory resets - these are where the returns get set every five years. We think that regulator will reduce returns. So, there could be some downside there. Given that these stocks have performed very well over the last year, we think maybe it's a good time to start switching into other types of infrastructure stocks or even defensive AREITS.
Grove: Finally, Adrian, what are the main risks that investors should remain cognizant of when investing in this space?
Atkins: The main risk is, I think, debt. There are other things to consider, of course, some of them do have some sort of economic cyclicality. There is regulatory risk for the regulated utilities and there is demand risk for the unregulated utilities, but by and large the biggest issue to watch is debt.
They are capital-intensive assets. They need to borrow money, and if credit markets freeze up then that is a potential risk. As I said though, I think, balance sheets are much improved and should be okay bar a severe credit crisis.
Grove: Adrian, thanks for joining us.
Atkins: No problem. Thank you for having me.
Grove: To read Adrian's recent special report Morningstar.com.au. Premium subscribers can go to the 'Special Reports' tab and click on the link below.